Wolfgang Munchau, who judging by how often Paul Krugman quotes him in his posts appears to be one of Paul Krugman’s favourite European commentators, has written another in his long series of articles in the Financial Times advocating a common eurobond as the solution to the euro crisis.
Whether a common eurobond would solve the euro crisis is debatable but no one should be under any illusions about what it means. It is in fact nothing more nor less than yet another device to get Germany to guarantee the whole of the eurozone’s sovereign debt.
A government bond is simply a pledge (like an IOU or a post dated cheque) to repay a debt at a certain date and a certain rate of interest, which is given to a lender by a government that is borrowing money. The extent to which a lender is prepared to accept such a bond in return for a loan depends on the solvency of the government that issues it. If the government that issues the bond is able to pay the debt out of money it is raising through taxes the government is solvent and the lender can be confident the bond will be honoured and the debt repaid making the bond low risk. If however the government that issues the bond has to borrow more money to honour the bond and pay off the debt then doubts about the government’s solvency might arise. In that case the lender might start to worry that the bond might not be honoured and the debt might not be paid in which case the lender might treat the bond as higher risk and might decline to accept it or might only accept it and lend against it at a higher rate of interest.
In practice some governments because of accumulated goodwill are seen as better risks than others. If so they may for a time be cut more slack and allowed to borrow for longer and on better terms than other governments. The underlying principle nevertheless holds true. To argue otherwise (as some extreme Keynesians seem at times to do) amounts to saying that government can be indefinitely run as a Ponzi scheme in which debt is paid by taking out more debt.
A common eurobond would however be different from every other bond trading in the sovereign bond market. This is because the issuer of a common eurobond would not be a government. The eurozone has no government . It would have to be some central eurozone institution, possibly the new stability fund or conceivably the European Central Bank. Neither however has any tax raising powers since the eurozone has no tax raising powers. In the absence of such tax raising powers the common eurobond could only be honoured from funds provided to the institution that issued it by eurozone governments. In practice that of course means the German government since the German government is the only eurozone government that could conceivably find the necessary money to honour the debt represented by the common eurobonds that had been issued.
What this means in practice is that the only way that a common eurobond could work would be if the German government publicly underwrote it. Since the purpose of the common eurobond would be to pay off other eurobond sovereign debt this would in effect mean that Germany would be accepting a transfer union and would be guaranteeing the whole of the eurozone’s sovereign debt. In my previous post I explained why Germany might not have sufficient resources to do this.
The problems in fact only start there. Germany would not just be guaranteeing the whole of the eurozone’s existing debt. The logic of common eurobonds is that Germany would be guaranteeing future eurozone debt as well. Moreover it would be debt over which Germany would have no control. How could Germany prevent say Italy from borrowing more if it wanted to? If eurozone governments such as Italy’s were to take advantage of the German guarantee implicitly provided by the issue of German backed common eurobonds at what point would Germany say that enough was enough and it was no longer prepared to underwrite the issue of still more common eurobonds to cover still more eurozone debt? What would then happen not just to Italy and the eurozone but also to the creditworthiness of Germany if that point were ever reached? The short answer is that there would be a default and Germany, which would be seen to have caused it, would see its creditworthiness destroyed.
In other words the idea of the common eurobond is every bit as flawed and as dangerous as the idea of allowing the European Central Bank to buy eurozone bonds by printing euros. As with that idea if everything were so simple it would surely by now have been done. That it has not been done is not because of German obduracy but because of the very real dangers inherent in this idea.
Before I finish with this post, I do want to make two further points:
1. One of the most troubling things about Wolfgang Munchau’s article is that he devotes a great deal of space explaining why a common eurobond is necessary because it creates the sort of “safe investment vehicle” the eurozone supposedly needs. I find this comment remarkable. As I hope I have shown in this post a common eurobond is not a safe investment vehicle. Besides, if the financial crisis has proved anything it is that there is no such thing as a “safe investment vehicle” and that to believe in such a thing is to believe in a mirage. Ultimately what caused the financial crisis was that people traded in financial instruments, which they believed were safe and which it turned out were not safe. It is alarming that four years after the start of the crisis in 2007 a reputable financial commentator such as Wolfgang Munchau still seems oblivious to this fact and continues to indulge in this fantasy.
2. In his blog Mark Chapman has suggested that one reason why there might now be some interest in integrating Russia into the European institutions is because with its massive financial reserves (currently the world’s third largest) Russia would be able materially to contribute to a eurozone bailout, which Germany by itself probably lacks the resources to do.
My own rather sour comment to this is that whilst the eurozone governments would doubtless be delighted to accept Russia’s help (in fact they have already asked for it) past experience shows that any promises they made in return for such help would be so much worthless currency. Recent articles by liberal journalists in Russia (including one discussed and commented upon by Mark Chapman on his blog) show that the fantasy of Russia joining the European Union is once again undergoing something of a revival in liberal circles in Russia. Given that this is so Russia can count itself lucky that it does not have a liberal government. Judging from these articles such a government would at this moment be busy bargaining away Russia’s hard earned financial reserves on a eurozone bailout in return for promises of eventual EU membership that would never be honoured.